Section 19 – Business Combinations and Goodwill
Summary
Section 19 deals with business combinations.
A business combination is the bringing together of separate entities or businesses into one reporting entity (Section 19.3). All business combinations (other than those that meet the definition of a group reconstruction, and public benefit entities) are accounted using the purchase method of accounting.
What is new?
The period for allowing adjustment to the fair values under Section 19 is the 12-month period after the date of acquisition. These adjustments are adjusted retrospectively (where the 12 months flows into the following year) and as a result a prior year adjustment is required. This contrasts with old GAAP (FRS 7) where the fair value could be adjusted prospectively up until the end of the first full financial year following acquisition.
Under Section 19, positive goodwill should be amortised on a systematic basis over the useful life, which cannot be indefinite. If there is no basis of estimation the default estimate of useful life is 10 years. (Note until the EU Directive 2013/34 has been adopted by Ireland Irish entities must use a maximum useful life of 5 years in absence of a reliable basis of estimation). This compares to old GAAP where the rebuttable presumption was 20 years and in some cases could be considered indefinite. Where under old GAAP a definite useful life was determined then it is likely there will be no change as this would still be applicable. So in practice it should only impact goodwill which was previously considered indefinite.
Section 19 requires an entity to test for impairment if impairment indicators exist. This contrasts with FRS 7 whereby goodwill which had an indefinite useful life or a life of over 20 years had to be reviewed for impairment annually. This will result in increased amortisation for companies who would previously have determined goodwill to have an indefinite life.
What is different?
Section 19.3 defines a business whereas under old GAAP (FRS 6) this was not defined. This will mean more scrutiny will have to be applied to assess if a business or just assets are being transferred. However, it is unlikely to create any major differences.
Recognition of contingent assets is not allowed under Section 19 whereas under old GAAP (FRS 7) this was allowed.
Section 19 does not require some of the disclosures that are included in FRS 6 namely:
- Details of provisions for reorganisation and restructuring costs that are included in the liabilities of the acquired entity, and related write downs made in the last 12 months;
- Details disclosed if provisional fair values were utilised and disclosures of subsequent material adjustments to the fair values with corresponding adjustments to goodwill were required to be explained;
- Details of profit after tax and minority interest for periods from beginning of the year to date of acquisition;
- Previously for group reconstructions there were detailed disclosures required however Section 19.25 only requires the method of accounting, and the date of the combination; and
- Under old GAAP, when assessing the fair value of inventory on acquisition, the fair value to be placed on inventory that was not traded in a market in which the acquirer participated as both a buyer and a seller at the date of acquisition was the lower of cost or net realisable value. This compares with FRS 102, where the fair value is based on what it can be sold for in the market irrespective of the market the acquirer operates in.
Other standards affecting Section 19 where differences arise:
Section 10 – Accounting policies, estimates and errors – Section 10 states that an adjustment to fair values require retrospective application which differs from old GAAP where they are adjusted prospectively.
Section 27 – Impairment of assets – This standard provides details of the impairment indicators and how an impairment review is to be carried out.
Section 29 -Income tax – Section 29 states that deferred tax is recognised on differences between acquisition fair value and tax base (including revaluations and intangibles ‘created’ as a result of the combination but excluding goodwill). Deferred tax is set against goodwill. This contrasts with old GAAP where deferred tax was not recognised on differences between acquisition fair value and tax base (only recognised if there was a binding sale).
Section 18 – Intangible assets other than goodwill – The default rate where expected life cannot be measured is 10 years (Note until the EU Directive 2013/34 has been adopted by Ireland Irish entities must use a maximum useful life of 5 years in absence of a reliable basis of estimation).
Section 18.8 deals with intangible assets acquired in a business combination. An intangible should not be recognised separately from goodwill if fair value cannot be measured reliably, otherwise, recognised at fair value at the date of acquisition. This compares with old GAAP (FRS 10) where it not only requires reliable measurement but also subject to the constraint that, unless the asset had a readily ascertainable market value, the value was limited to an amount that did not create or increase any negative goodwill arising on acquisition. This will mean that it is likely more intangibles will be created on acquisition which will result in less goodwill.
Section 28 – Employee benefits – potential for defined benefit scheme to be included on acquisition where previously it was treated as a defined contribution scheme under old GAAP. However, given the transition exemption opening balance for previous combinations will not have to be restated.
Section 35 – Transition to FRS 102 – Exemption not to restate business combinations to the requirements of Section 19 – Goodwill and Business Combinations, for business combinations entered in to prior to the date of transition. However, even where this exemption is availed of, on transition an entity will need to calculate the deferred tax on any fair value adjustments (other than on goodwill) on prior business combinations, with the corresponding amount posted to profit and loss reserves as opposed to goodwill.
What are the key points?
- Goodwill is the difference between the acquirer’s interest in the net amount of identifiable assets acquired and the cost of the business combination. After initial recognition it is carried at cost less accumulated amortisation and impairments;
- Acquired assets/liabilities etc. are initially measured at fair value except deferred tax and employee benefits;
- The purchase method of accounting is to be used on all acquisition with the exception of certain group reconstructions and public benefit entities;
- Contingent consideration is recognised in the purchase cost if probable that it can be reliably measured with subsequent adjustments going to goodwill (Section 19.12). Contingent consideration may need to be present valued depending on the time period;
- Adjustments to the estimates of fair values can be made within 12 months of the acquisition however if the adjustment straddles the following year they must be adjusted for retrospectively;
- Measure non-controlling interest at share of net assets;
- Cost of business combination is the total of fair value of assets given, liabilities assumed and equity instruments issued at each stage of the transaction plus directly attributable costs;
- Test for impairment in line with Section 27 only if impairment indicators exist.
- Negative goodwill is firstly allocated against the fair value of the non-monetary assets in period in which non-monetary assets recovered and the balance against the period in which the entity is likely to benefit;
- Less onerous disclosures under Section 19 than was under FRS 7;
- Recognise deferred tax on difference between fair values on acquisition and tax base;
- Likely to be more amortisation in the profit and loss account due to more intangibles recognised as criteria not as strict as well as a rebuttable assumption where a useful life cannot be reliably measured of 10 years;
- Direct transaction costs capitalised; and
- Merger accounting permitted for group reconstructions where the ultimate equity holders remain the same. Under this method fair valuing is not required.
What do accountants need to do?
Be aware of the differences between Section 19 and old GAAP.
Review the client portfolio for client companies that engage in business acquisitions and combinations and advise them of the differences.
Advise clients of the potential for increased amortisation in the profit and loss if the reliable estimate of the life of goodwill cannot be measured.
Advise clients of the need to retrospectively account for adjustments to contingent consideration and fair values.
Advise companies on the impact on distributable reserves as a result of the need for the recognition of deferred tax on the fair value adjustments. In particular, work with clients who have made acquisition since the date of transition so that transition adjustments can be determined e.g. any additional intangibles to be recognised or deferred tax (note this includes deferred tax on share acquisitions).
Inform clients who have goodwill which is being amortised over more than 20 years, the non-necessity to do an impairment review on a yearly basis under the new standard.
Work with clients to ensure they review goodwill previously considered to have an indefinite life; and assess whether a life can be determined otherwise inform clients of the consequences of depreciating this over 5/10 years and the impact on profits and distributable reserves.
Advise clients of the transition exemption available not to restate business combinations entered into prior to the date of transition. Advise even where this exemption is availed of, deferred tax on any fair value adjustments will need to be recognised within profit and loss reserves on transition.
What do companies need to do?
Determine whether Section 19 is applicable and if so, determine the difference between Section 19 and old GAAP.
For acquisitions since 1 January 2014 (assuming a 31 December year-end), review the acquisition accounting required under FRS 102 and assess the goodwill and deferred tax adjustments required.
Consider whether work-loads can be reduced given the new requirement for impairment reviews to only be performed once impairment indicators exists.
Assess whether the exemption available in Section 35 not to restate goodwill previously recognised under old GAAP should be claimed.